Acclaimed Silicon Valley Journalist Brad Stone has been covering Amazon since its early days. “The Everything Store,” is a result of Stone drawing upon his writing experience and interviewing numerous Amazon executives, with the blessings of Jeff Bezos. The book provides a comprehensive account of Amazon’s growth from its 1996 inception until 2013, the year of publishing.
Reading the book was fruitful because it gave me a window into Amazon’s way of thinking & helped me understand Amazon’s complex business by breaking it down into distinct components. I’ve structured my book notes such that they should do the same for you as well.
And if you are thinking how much better it would have been if “The Everything Store” covered Amazon’s story until 2020, I have some good news. Stone has announced a sequel named ‘Amazon Unbound’ to deconstruct how Amazon has since grown from being an “everyhting store” to an “everything company,” aiming for publication in 2021.
Book Notes of ‘The Everything Store’ by ‘Brad Stone’
No PowerPoint Culture
Amazon’s internal customs are deeply idiosyncratic. PowerPoint decks or slide presentations are never used in meetings. Instead, employees are required to write six page narratives laying out their points in prose, because Bezos believes doing so fosters critical thinking. For each new product, they craft their documents in the style of a press release. The goal is to frame a proposed initiative in the way a customer might hear about it for the first time. Each meeting begins with everyone silently reading the document, and discussion commences afterward.
The Narrative Fallacy
Before working on ‘The Everything Store’, Brad Stone met Jeff Bezos seeking co-operation for writing the book. Hoping to impress Jeff, Stone presented a fictional press release of the book in typical Amazonian fashion. Towards the end of their discussion, Bezos asked a question Stone wasn’t prepared to answer, “How do you plan to handle the narrative fallacy?”
The narrative fallacy, Bezos explained, was a term coined by Nassim Nicholas Taleb in his 2007 book The Black Swan to describe how humans are biologically inclined to turn complex realities into soothing but oversimplified stories. Taleb argued that the limitations of the human brain resulted in our species’ tendency to squeeze unrelated facts and events into cause-and-effect equations and then convert them into easily understandable narratives. These stories, Taleb wrote, shield humanity from the true randomness of the world, the chaos of human experience, and, to some extent, the unnerving element of luck that plays into all successes and failures.
In Taleb’s book—which, incidentally, all Amazon senior executives had to read— the author stated that the way to avoid the narrative fallacy was to favor experimentation and clinical knowledge over storytelling and memory.
What Distinguishes Amazon from Competitors
“If you want to get to the truth about what makes us different, it’s this, ” Bezos says, “We are genuinely customer-centric, we are genuinely long-term oriented and we genuinely like to invent. Most companies are not those things. They are focused on the competitor, rather than the customer. They want to work on things that will pay dividends in two or three years, and if they don’t work in two or three years they will move on to something else. And they prefer to be close followers rather than inventors, because it’s safer. So if you want to capture the truth about Amazon, that is why we are different. Very few companies have all of those three elements.”
Why, of all the Product Categories, Amazon Choose to Sell Books First
They were pure commodities; a copy of a book in one store was identical to the same book carried in another, so buyers always knew what they were getting. There were two primary distributors of books at that time, Ingram and Baker and Taylor, so a new retailer wouldn’t have to approach each of the thousands of book publishers individually. And, most important, there were three million books in print worldwide, far more than a Barnes & Noble or a Borders superstore could ever stock.
Regret Minimization Framework
In 1994, at the age of 29, when faced with the decision of either sticking to his well-paying corporate job or venturing out on his own, Bezos came up with “the regret-minimization framework”
“When you are in the thick of things, you can get confused by small stuff, ” Bezos said a few years later. “I knew when I was eighty that I would never, for example, think about why I walked away from my 1994 Wall Street bonus right in the middle of the year at the worst possible time. That kind of thing just isn’t something you worry about when you’re eighty years old. At the same time, I knew that I might sincerely regret not having participated in this thing called the Internet that I thought was going to be a revolutionizing event. When I thought about it that way… it was incredibly easy to make the decision.
Backlash against Introducing Reviews
In speeches, Bezos later recalled getting an angry letter from an executive at a book publisher implying that Bezos didn’t understand that his business was to sell books, not trash them. “We saw it very differently, ” Bezos said. “When I read that letter, I thought, we don’t make money when we sell things. We make money when we help customers make purchase decisions.
Amazon’s Affiliate Program
When other websites redirected customers to Amazon to buy a book, the company gave these approved sites an 8 percent commission for the referral. The Associates program wasn’t exactly the first of its kind, but it was the most prominent and it helped spawn a multibillion-dollar-a-year industry called affiliate marketing. It also allowed Amazon, very early on, to extend its reach across the Web to other sites, entrenching it in advance of the looming competition.
The Impact of User Personalization on Commerce
Bezos believed that this would be one of the insurmountable advantages of e-commerce over its brick-and-mortar counterparts. “Great merchants have never had the opportunity to understand their customers in a truly individualized way, ” he said. “E-commerce is going to make that possible.”
Expanding Beyond Books
Amazon executives chose music as the first expansion target, and DVDs as the second. To the discomfort of early employees wedded to the zeal of creating a literary hub on the Web, the mission was now more comprehensive. The motto on the top of the website changed from Earth’s Largest Bookstore to Books, Music and More, and, soon after, to Earth’s Biggest Selection—the everything store.
The First Letter to Amazon’s Public Shareholders
In the company’s first letter to its public shareholders, written collaboratively by Bezos and Joy Covey and typed up by treasurer Russ Grandinetti in early 1998, the word bold was used repeatedly. “We will make bold rather than timid investment decisions where we see a sufficient probability of gaining market leadership advantages, ” they wrote. “Some of these investments will pay off, others will not, and we will have learned another valuable lesson in either case.” The letter also stated that the company would make decisions based on long-term prospects of boosting free cash flow and growing market share rather than on short-term profitability.
Adding Toys & Electronics to the Product Mix
The expansion into selling music and DVDs in 1998 had gone well, with Amazon quickly surpassing the early leaders in each market, including a startup called CDNow.com in music and Reel.com in movies. At first Amazon couldn’t get music labels and movie studios to supply it directly. But as in the book business, there were intermediary distributors, like Baker and Taylor, that gave Amazon an initial boost and then allowed it to credibly make its case directly to the big media companies. At the beginning of 1999, an emboldened Bezos selected toys and electronics as two of the company’s primary new targets.
Welcoming Third-Party Sellers on Amazon
The effort started with used books. Other sellers of books were invited to advertise their wares directly within a box on Amazon’s own book pages. Customers got to choose whether to purchase the item from Amazon itself or from a third-party seller. If they chose the latter, either because the seller had a lower price or because the product was out of stock at Amazon, the company would lose the sale but collect a small commission. “Jeff was super clear from the beginning, ” says Neil Roseman. “If somebody else can sell it cheaper than us, we should let them and figure out how they are able to do it.
Amazon’s Pricing Strategy
“There are two kinds of retailers: there are those folks who work to figure how to charge more, and there are companies that work to figure how to charge less, and we are going to be the second, full-stop” — Jeff Bezos
Lower prices led to more customer visits. More customers increased the volume of sales and attracted more commission-paying third party sellers to the site. That allowed Amazon to get more out of fixed costs like the fulfillment centers and the servers needed to run the website. This greater efficiency then enabled it to lower prices further.
Saving Marketing Dollars & Investing them into Improving the Customer Experience
Bezos had the marketing department organize tests, running commercials in only the Minneapolis and Portland media markets and measuring whether they generated an uptick in local purchases. They did—but, Bezos concluded, not enough to justify the investment.
“It was pretty clear afterward that TV advertising wasn’t really having an impact, ” says Mark Stabingas, a finance vice president who joined the company from Pepsi.
Bezos felt that word of mouth could deliver customers to Amazon. He wanted to funnel the saved marketing dollars into improving the customer experience and accelerating the flywheel. And as it happened, at the time, Amazon was conducting an experiment that was actually working this way—free shipping.
During the 2000 and 2001 holidays, Amazon offered free shipping to customers who placed orders of a hundred dollars or more. The promotion was expensive but clearly boosted sales. Customer surveys showed that shipping costs were one of the biggest hurdles to ordering online. Amazon hadn’t yet found a good way to convince customers to shop in multiple categories—to buy books, kitchen appliances, and software, for example, all at the same time. The hundred-dollar threshold motivated buyers to fill their baskets with a variety of items.
In early 2002 late on a Monday night, Bezos called a meeting in Warren Jenson’s conference room to talk about how to turn the holiday-season free shipping into a permanent offer. This was one way he could redeploy his marketing budget. Jenson in particular was opposed to this. The CFO worried that free shipping would be expensive and wasteful, since Amazon would be giving discounts to all comers, including those customers who were inclined to place large orders anyway.
Then one of his deputies, a finance vice president named Greg Greeley, mentioned how airlines had segmented their customers into two groups—business people and recreational travelers—by reducing ticket prices for those customers who were willing to stay at their destination through a Saturday night. Greeley suggested doing the equivalent at Amazon. They would make the free-shipping offer permanent, but only for customers who were willing to wait a few extra days for their order. Just like the airlines, Amazon would, in effect, divide its customers into two groups: those whose needs were time sensitive, and everyone else. The company could then reduce the expense of free shipping, because workers in the fulfillment centers could pack those free-shipping orders in the trucks that Amazon sent off to express shippers and the post office whenever the trucks had excess room. Bezos loved it. “That is exactly what we are going to do, ” he said.
Amazon introduced the service, called Free Super Saver Shipping, in January 2002 for orders above $99. In the span of a few months, that number dropped to $49, and then to $25. Super Saver Shipping would set the stage for a variety of new initiatives in the years ahead, including the subscription club Amazon Prime.
“It’s harder to be kind than clever.”
Bezos’s grandparents taught him a lesson in compassion that he related decades later, in a 2010 commencement speech at Princeton. Every few years Pop and Mattie Gise hooked an Airstream trailer to their car and caravanned around the country with other Airstream owners, and they sometimes took Jeff with them. On one of these road trips, when Bezos was ten and passing time in the back seat of the car, he took some mortality statistics he had heard on an antismoking public service announcement and calculated that his grandmother’s smoking habit would take nine years off her life. When he poked his head into the front seat to matter-of-factly inform her of this, she burst into tears, and Pop Gise pulled over and stopped the car.
In fact, Mattie Gise fought cancer for years and would eventually succumb to it. Bezos described what happened next in his speech at Princeton.
He got out of the car and came around and opened my door and waited for me to follow. Was I in trouble? My grandfather was a highly intelligent, quiet man. He had never said a harsh word to me, and maybe this was to be the first time? Or maybe he would ask that I get back in the car and apologize to my grandmother. I had no experience in this realm with my grandparents and no way to gauge what the consequences might be. We stopped beside the trailer. My grandfather looked at me, and after a bit of silence, he gently and calmly said, “Jeff, one day you’ll understand that it’s harder to be kind than clever.”
Communicating More is a Sign of Dysfunction
At a management offsite in the late 1990s, a team of well-intentioned junior executives stood up before the company’s top brass and gave a presentation on a problem indigenous to all large organizations: the difficulty of coordinating far-flung divisions. The junior executives recommended a variety of different techniques to foster crossgroup dialogue and afterward seemed proud of their own ingenuity. Then Jeff Bezos, his face red and the blood vessel in his forehead pulsing, spoke up.
“I understand what you’re saying, but you are completely wrong, ” he said. “Communication is a sign of dysfunction. It means people aren’t working together in a close, organic way. We should be trying to figure out a way for teams to communicate less with each other, not more.”
Solving Fulfillment Center Inefficiencies
Amazon operated an e-commerce distribution network of unrivaled scale but the company was still struggling to run it efficiently. Its seven fulfillment centers around the world were expensive, their output inconsistent. Bezos wanted the Amazon website to be able to tell customers precisely when their packages would be delivered. For example, a college student ordering a crucial book for a final exam should know that the book would be delivered the following Monday. But the fulfillment centers were not yet reliable enough to make that kind of specific prediction.
Amazon’s problem boiled down to something called, in the esoteric lexicon of manufacturing, batches. The equipment in Amazon’s FCs had originally been acquired by Jimmy Wright, and, like the system in Walmart’s distribution centers, was designed by its manufacturers to operate in waves—moving from minimum capacity to maximum and then back again. At the start of a wave, a group of workers called pickers fanned out across the stacks of products, each in his or her own zone, to retrieve the items ordered by customers. At the time, Amazon used the common pick-to-light system. Various lights on the aisles and on individual shelves guided pickers to the right products, which they would then deposit into their totes—a cart of the picks from that wave. They then delivered their totes to conveyor belts that fed into the giant sorting machines, which rearranged products into customer orders and sent them off on a new set of conveyor belts to be packed and shipped.
The software required pickers to work individually, but, naturally, some took longer than others, which led to problems. For example, if ninety-nine pickers completed their batches within forty-five minutes but the one hundredth picker took an additional half an hour, those ninety-nine pickers had to sit idly and wait. Only when that final tote cleared the chute did the system come fully alive again, with a thunderous roar that rolled through the fulfillment center and indicated that it was again ready to start operating at peak capacity.
Everything in the fulfillment center happened in this episodic manner. For a company trying to maximize its capacity during the big push each holiday season, that was a huge problem. Wilke subscribed to the principles laid out in a seminal book about constraints in manufacturing, Eliyahu M. Goldratt’s The Goal, published in 1984. The book, cloaked in the guise of an entertaining novel, instructs manufacturers to focus on maximizing the efficiency of their biggest bottlenecks. For Amazon, that was the Crisplant sorting machines, where the products all ended up, but picking in batches limited how fast the sorters could be fed. As a result, the machines were operating at full capacity only during the brief few minutes at the peak of the batch. Wilke’s group had experimented with trying to run overlapping waves, but that tended to overload the Crisplant sorters.
Bezos, Wilke, and their colleagues reached a conclusion: the equipment and software from third-party vendors simply wasn’t designed for the task at hand. To escape from batches and move toward a continuous and predictable flow of orders through the facility, Amazon would have to rewrite all the software code. Instead of exiting the business of distribution, they had to reinvest in it.
Over the next few years, “one by one, we unplugged our vendors’ modems and we watched as their jaws hit the floor, ” says Wegner. “They couldn’t believe we were engineering our own solutions.” When Amazon later opened small facilities in places like Seattle and Las Vegas to handle easily packable items and larger fulfillment centers in Indianapolis, Phoenix, and elsewhere, it would go even further, dispensing with the pick-to-light systems and big Crisplant sorting machines altogether and instead employing a less automated approach that favored invisible algorithms. Employees would bring their totes from the shelves right to the packing stations, their movements carefully coordinated by software. Slowly, Amazon would vanquish wave-based picking, elicit more productivity from its workers, and improve the accuracy and reliability of its fulfillment centers.
Wilke’s gradual success in making the logistics network more efficient would offer Amazon innumerable advantages in the years ahead. Tightly controlling distribution allowed the company to make specific promises to customers on when they could expect their purchases to arrive. Amazon’s operating all of its own technology, from the supply chain to the website, allowed Russell Allgor and his engineers to create algorithms that modeled countless scenarios for each order so systems could pick the one that would yield the quickest and cheapest delivery. Millions of those decisions could be made every hour, helping Amazon reduce its costs—and thus lower prices and increase volume of sales.
Leveraging Scale in Negotiations
In 2002, Jeff Wilke led the first significant effort to use Amazon’s now impressive size to exact concessions from a major business partner: the United Parcel Service. That year, Amazon’s contract with UPS was up for renewal, and the package-delivery giant, embroiled in a separate standoff with the Teamsters Union, did not appear to be in the mood to grant more-favorable terms to the online upstart. Amazon wasn’t using Federal Express in any significant way at the time, and the primary alternative to UPS, the federally managed U.S. Postal Service, was not permitted to negotiate its rates. Amazon, it seemed, had no leverage.
But early that year, sensing an opportunity, Wilke approached Bruce Jones in Operations and asked him to begin cultivating FedEx. Over the course of six months, Jones and a team traveled frequently to FedEx’s headquarters in Memphis, integrating their systems and quietly ratcheting up the volume of packages. Amazon also increased its shipment injections with the U.S. Postal Service: company employees drove Amazon’s trucks to the post office and inserted packages directly into the flow of federal mail.
Wilke started his negotiations with UPS that summer in Louisville, ahead of a September 1 contract deadline. When UPS was predictably obstinate about deviating from its standard rate card, Wilke threatened to walk. UPS officials thought he was bluffing. Wilke called Jones in Seattle and said, “Bruce, turn them off.”
“In twelve hours, they went from millions of pieces [from Amazon] a day to a couple a day, ” says Jones, who flew to Fernley to watch the fallout. The standoff lasted seventy-two hours and went unnoticed by customers and other outsiders. In Fernley, UPS representatives told Jones they knew Amazon couldn’t keep it up and predicted that FedEx would be overwhelmed. They were likely right. But before it came to that, UPS execs caved and gave Amazon discounted rates.
“Yes, we could have operated mostly without them, ” Wilke says. “But it would have been very hard, very painful. They knew that. I didn’t want to leave them, I just wanted a fair price.” In the end, he got one, bringing home one of Amazon’s first bulk discounts and teaching the company an enduring lesson about the power of scale and the reality of Darwinian survival in the world of big business.
The Genesis of Amazon Prime
In 2004, an Amazon engineer named Charlie Ward used an employee-suggestion program called the Idea Tool to make a proposal. Super Saver Shipping, he reasoned, catered to price-conscious customers whose needs were not time sensitive—they were like the airline travelers who paid a lower rate because they stayed at their destinations over a Saturday night. Their orders got placed on the trucks whenever there was room for them, reducing the overall shipping cost. Why not create a service for the opposite type of customer, Ward suggested, a speedy shipping club for consumers whose needs were time sensitive and who weren’t price conscious? He suggested that it could work like a music club, with a monthly charge.
Selecting the fee for the service was a challenge; there were no clear financial models because no one knew how many customers would join or how joining would affect their purchasing habits. The group considered several prices, including $49 and $99. Bezos decided on $79 per year, saying it needed to be large enough to matter to consumers but small enough that they would be willing to try it out. “It was never about the seventy-nine dollars. It was really about changing people’s mentality so they wouldn’t shop anywhere else, ” says Ravindran, who later became chief digital officer for the Washington Post.
In many ways, the introduction of Amazon Prime was an act of faith. The company had little concrete idea how the program would affect orders or customers’ likelihood to shop in other categories beyond media. If each expedited shipment cost the company $8, and if a shipping-club member placed twenty orders a year, it would cost the company $160 in shipping, far above the $79 fee. The service was expensive to run, and there was no clear way to break even. “We made this decision even though every single financial analysis said we were completely crazy to give two-day shipping for free, ” says Diego Piacentini.
But Bezos was going on gut and experience. He knew that Super Saver Shipping had changed customers’ behavior, motivating them to place bigger orders and shop in new categories. He also knew from 1-Click ordering that when friction was removed from online shopping, customers spent more. That accelerated the company’s fabled flywheel—the virtuous cycle. When customers spent more, Amazon’s volumes increased, so it could lower shipping costs and negotiate new deals with vendors. That saved the company money, which would help pay for Prime and lead back to lower prices.
Prime would eventually justify its existence. The service turned customers into Amazon addicts who gorged on the almost instant gratification of having purchases reliably appear two days after they ordered them. Signing up for Amazon Prime, Jason Kilar said at the time, “was like going from a dial-up to a broadband Internet connection.” The shipping club also keyed off a faintly irrational human impulse to maximize the benefits of a membership club one has already joined. With the punitive cost of expedited shipping, Amazon lost money on Prime membership, at first. But gradually Wilke’s organization got better at combining multiple items from a customer’s order into a single box, which saved money and helped drive down Amazon’s transportation costs by double-digit percentages each year.
Fulfillment by Amazon
Prime opened up new doors, and the next year Amazon introduced a service called Fulfillment by Amazon, or FBA. The program allowed other merchants to have their products stored and shipped from Amazon’s fulfillment centers. As an added benefit, their products qualified for two-day shipping for Prime members, exposing the sellers to Amazon’s most active customers. For Wilke’s logistics group, it was a proud moment. “That is when it really hit home, ” says Bert Wegner. “We had built such a good service that people were willing to pay us to use it.”
How Amazon’s Internal Bottleneck gave Birth to AWS
While Amazon’s internal systems had been broken down into more durable individual components, Amazon’s technical staff was still organized conventionally as a single team, headquartered in a separate office building downtown near Seattle’s Union Station. This group strictly controlled who could access Amazon’s servers, and various teams inside the company had to plead for resources to try out their new projects and features. The process slowed down and frustrated many Amazon project managers.
At the same time, Bezos became enamored with a book called Creation, by Steve Grand, the developer of a 1990s video game called Creatures that allowed players to guide and nurture a seemingly intelligent organism on their computer screens. Grand wrote that his approach to creating intelligent life was to focus on designing simple computational building blocks, called primitives, and then sit back and watch surprising behaviors emerge.
The book…helped to crystallize the debate over the problems with the company’s own infrastructure. If Amazon wanted to stimulate creativity among its developers, it shouldn’t try to guess what kind of services they might want; such guesses would be based on patterns of the past. Instead, it should be creating primitives — the building blocks of computing — and then getting out of the way. In other words, it needed to break its infrastructure down into the smallest, simplest atomic components and allow developers to freely access them with as much flexibility as possible.
AWS Mission Statement
“To enable developers and companies to use Web services to build sophisticated and scalable applications.”
Andy Jassy, AWS CEO, describing the thought behind AWS
“We tried to imagine a student in a dorm room who would have at his or her disposal the same infrastructure as the largest companies in the world, ” Jassy says. “We thought it was a great playing-field leveler for startups and smaller companies to have the same cost structure as big companies.”
Deflecting Competition Using Discounting
Bezos wanted AWS to be a utility with discount rates, even if that meant losing money in the short term. Willem van Biljon, who worked with Chris Pinkham on EC2, proposed pricing EC2 instances at fifteen cents an hour, a rate that he believed would allow the company to break even on the service. In an S Team meeting before EC2 launched, Bezos unilaterally revised that to ten cents. “You realize you could lose money on that for a long time, ” van Biljon told him. “Great, ”Bezos said.
Bezos believed his company had a natural advantage in its cost structure and ability to survive in the thin atmosphere of low-margin businesses. Companies like IBM, Microsoft, and Google, he suspected, would hesitate to get into such markets because it would depress their overall profit margins. Bill Miller, the chief investment officer at Legg Mason Capital Management and a major Amazon shareholder, asked Bezos at the time about the profitability prospects for AWS. Bezos predicted they would be good over the long term but said that he didn’t want to repeat “Steve Jobs’s mistake” of pricing the iPhone in a way that was so fantastically profitable that the smartphone market became a magnet for competition.
The comment reflected his distinctive business philosophy. Bezos believed that high margins justified rivals’ investments in research and development and attracted more competition, while low margins attracted customers and were more defensible.
Bezos’s belief was borne out, and AWS’s deliberately low rates had their intended effect; Google chairman Eric Schmidt said it was at least two years before he noticed that the founders of seemingly every startup he visited told him they were building their systems atop Amazon’s servers. “All of the sudden, it was all Amazon, ” Schmidt says. “It’s a significant benefit when every interesting fast-growing company starts on your platform.” Microsoft announced a similar cloud initiative called Azure in 2010. In 2012, Google announced its own Compute Engine.“
A Technology company, not a Retailer
The emergence of Amazon Web Services was transformational in a number of ways. Amazon’s inexpensive and easily accessible Web services facilitated the creation of thousands of Internet startups, some of which would not have been possible without it, and it provided larger companies with the ability to rent a supercomputer in the cloud, ushering in a new era of innovation in areas like finance, oil and gas, health, and science. It is not hyperbole to say that AWS, particularly the original services like S3 and EC2, helped lift the entire technology industry out of a prolonged post-dot-com malaise. Amazon also completely outflanked the great hardware makers of the time, like Sun Microsystems and Hewlett-Packard, and defined the next wave of corporate computing.
Perhaps the greatest makeover was of Amazon’s own image. AWS enlarged the scope of what it meant to be the everything store and stocked Amazon’s shelves with incongruous products like spot instances and storage terabytes. It made Amazon a confusing target for Walmart and other rival retailers and gave the company fresh appeal to the legions of engineers looking to solve the world’s most interesting problems. Finally, after years of setbacks and internal rancor, Amazon was unquestionably a technology company, what Bezos had always imagined it to be.
Sowing the Seeds for Kindle
In 2004, Apple’s dominance in digital music spawned fresh soul-searching at Amazon. The sales of books, music, and movies accounted for 74 percent of Amazon’s annual revenues that year. If those formats were inevitably transitioning to digital, as Apple’s accomplishment seemed to demonstrate, then Amazon had to move quickly to protect itself.
Seeking a digital strategy for Amazon amid the gathering power of a revived Apple Computer, Bezos started a secretive Silicon Valley skunkworks with the mysterious name Lab126. The hardware hackers at Lab126 were given a difficult job: they were to disrupt Amazon’s own successful bookselling business with an e-book device.
Internal Objections against Kindle
Creating hardware was expensive and complicated. It was also well outside of Amazon’s core competency—its litany of obvious skills. There was a chorus of vehement objections. Jeff Wilke in particular had the background in manufacturing to know what challenges lay ahead for the company if it tried to make and sell its own devices. “I thought it would be difficult and disruptive and I was skeptical that it was the right use of our resources, ” he says. “It turned out that most of the things I predicted would happen actually happened, and we still powered through it because Jeff is not deterred by short-term setbacks.”
Diego Piacentini also protested. He had watched firsthand as Apple struggled through the 1990s with disastrous surpluses of products and massive inventory write offs. “It was seen by me and all the small thinkers as a very risky investment, ” he says.
Bezos dismissed those objections and insisted that to succeed in books as Apple had in music, Amazon needed to control the entire customer experience, combining sleek hardware with an easy-to-use digital bookstore. “We are going to hire our way to having the talent, ” he told his executives in that meeting. “I absolutely know it’s very hard. We’ll learn how to do it.”
The Innovator’s Dilemma
Steve Kessel, a Boston-born graduate of Dartmouth College and the Stanford University Graduate School of Business, joined Amazon in the heat of the 1999 expansion after a job consulting for browser pioneer Netscape. In his first few years at the company, he ran the book category at a time when Amazon was cultivating direct relationships with publishers and trying to assuage their fears about third-party merchants selling used books on the site. During this grinding period of Amazon’s greatest challenges, Bezos grew to trust him immensely. One day in 2004, Bezos called Kessel into his office and abruptly took away his impressive job, with all of its responsibilities and subordinates. He said he wanted Kessel to take over Amazon’s fledgling digital efforts. Kessel was skeptical. “My first reaction was that I already had the best job in the world, ” he says. “Ultimately Jeff talked about building brand-new things, and I got excited by the challenge.” Bezos was adamant that Kessel could not run both the physical and digital-media businesses at the same time. “If you are running both businesses you will never go after the digital opportunity with tenacity, ” he said.
By that time, Bezos and his executives had devoured and raptly discussed another book that would significantly affect the company’s strategy: The Innovator’s Dilemma, by Harvard professor Clayton Christensen. Christensen wrote that great companies fail not because they want to avoid disruptive change but because they are reluctant to embrace promising new markets that might undermine their traditional businesses and that do not appear to satisfy their short-term growth requirements. Sears, for example, failed to move from department stores to discount retailing; IBM couldn’t shift from mainframe to minicomputers. The companies that solved the innovator’s dilemma, Christensen wrote, succeeded when they “set up autonomous organizations charged with building new and independent businesses around the disruptive technology.”
Drawing lessons directly from the book, Bezos unshackled Kessel from Amazon’s traditional media organization. “Your job is to kill your own business, ” he told him. “I want you to proceed as if your goal is to put everyone selling physical books out of a job.” Bezos underscored the urgency of the effort. He believed that if Amazon didn’t lead the world into the age of digital reading, then Apple or Google would. When Kessel asked Bezos what his deadline was on developing the company’s first piece of hardware, an electronic reading device, Bezos told him, “You are basically already late.”
Amazon Overtakes eBay
At the same time that Amazon’s flywheel was accelerating, eBay’s was flying apart. The appeal of online auctions had faded; a customer wanted the convenience and certainty of a quickly completed purchase, not a seven-day waiting period to see if his aggressively low bid for a set of Cobra golf clubs had won the day.
But eBay’s problems went beyond the overripening of the auctions format. Amazon and eBay had taken diametrically opposite paths. Amazon endured the pain of disrupting its own retail business with its eBay-like Amazon Marketplace, which allowed third-party sellers to list their products on the company’s single-detail pages; eBay, which had started as a third-party auctions platform, recognized that many of its customers wanted a more Amazon-like fixed-price alternative but failed to self administer the necessary bitter medicine in a single dose. It spent two years working on a separate destination for fixed-price retail, called eBay Express, which got no traffic when it debuted in 2006 and was quickly shut down. Only then did eBay finally commit to allowing fixed-price sales to share space alongside auctions on the site and in search results on eBay.com.
Meanwhile, Amazon invested heavily in technology, taking aggressive swings with digital initiatives like the Kindle. Amazon also focused on fixing and improving the efficiency of its fulfillment centers. EBay executives searched for high-growth businesses elsewhere, acquiring the calling service Skype in 2005, the online-ticketing site StubHub in 2007, and a series of classified-advertising websites. But it let its primary site wither. Customers became happier over time with the shopping experience on Amazon and progressively more disgruntled with the challenges of finding items on eBay and dealing with sellers who overcharged for shipping. Amazon had battled and mastered chaos; eBay was engulfed by it.
In 2008 Meg Whitman passed eBay’s reins to John Donahoe, a tall and gracious onetime Dartmouth College basketball player and a former consultant for Bain and Company. One of Donahoe’s first trips in his new capacity was to Seattle, where he went to pay a courtesy visit to Bezos at Amazon’s headquarters. The executives talked about innovation, hiring, and how they got enough exercise and dealt with stress. Bezos was now working out regularly and was on a strict lean-protein diet.
At the meeting, Donahoe paid his respects to the e-commerce pioneer. “I am always going to be less cool than you, ” he told Bezos. “I have huge admiration for what you’ve done.” Bezos said that he did not view Amazon and eBay as fighting a winner take-all battle. “Our job is to grow the e-commerce pie and if we do that there is going to be room for five Amazons and five eBays, ” Bezos said. “I’ve never said a negative thing about eBay and I never will. I don’t want anyone to view this as a zero-sum game.”
That year, eBay’s stock lost over half its market value, and in July, Amazon’s valuation surpassed eBay’s for the first time in nearly a decade. Bezos had now accomplished many of his early goals, like turning Amazon into the primary storefront on the Web. The website was selling more kinds of things—and just generally selling more things—than ever before. Amazon reported $14.8 billion in sales in 2007, which was more than two of its earliest foes combined could boast: Barnes & Noble pulled in $5.4 billion that year, and eBay $7.7 billion.
Why Amazon Changed its Acquisition Strategy
The lessons learned from its early acquisition spree in the late 1990s were still felt inside the company. Amazon had impulsively spent hundreds of millions to buy unproven startups that it could not digest and whose executives almost all left. In the resulting retrenchment, Amazon became uniquely parsimonious in how it approached mergers and acquisitions. Between 2000 and 2008, it acquired just a few companies, among which were the Chinese e-commerce site Joyo (bought in 2004 for $75 million), the print-on-demand upstart BookSurge (bought in 2005 for an undisclosed amount), and audio-book company Audible (bought in 2008 for $300 million). These deals were paltry by the standards of the broader technology industry. During this span of time, for example, Google bought YouTube for $1.65 billion and DoubleClick for $3.1 billion.
Jeff Blackburn, Amazon’s chief of business development, said that Amazon’s bruises from the 1990s helped to create a “building culture” there. Every major company faces decisions over whether it should build or buy new capabilities. “Jeff almost always prefers to build it, ” Blackburn says. Bezos had absorbed the lessons of the business bible Good to Great, whose author, Jim Collins, counseled companies to acquire other firms only when they had fully mastered their virtuous circles, and then “as an accelerator of flywheel momentum, not a creator of it.
Amazon’s Vs Third-Party Sellers
Some of the retailers who sell via the Amazon Marketplace seem to have a schizophrenic relationship with the company, particularly if they have no unique and sustainable selling point, such as an exclusive on a particular product. Amazon closely monitors what they sell, notices any briskly selling items, and often starts selling those products itself. By paying Amazon commissions and helping it source hot products, retailers on the Amazon Marketplace are in effect aiding their most ferocious competitor.
Amazon Prime Video
Like everyone else, Amazon executives knew that the days of selling and shipping physical DVDs were numbered, but they wanted to be prepared and well positioned for whatever came next. So Amazon opened DVD-rental services in the United Kingdom and Germany, with the idea that it would learn the rental business and establish its brand in markets that Netflix had not yet entered. But local companies were ahead there too, and the cost to acquire new customers was higher than Amazon had anticipated. In February 2008, Amazon seemingly waved the white flag of surrender, selling those divisions to a larger competitor, Lovefilm, in exchange for about $90 million in stock and a 32 percent ownership position in the European firm. Jeff Blackburn says that by then Amazon suspected there was little future for the rental model and that “we sold them the DVD business because they seemed to be overvaluing it.”
Lovefilm was a kind of Frankenstein corporate creation, the combination of numerous Netflix clones that had gradually merged with one other and come to control a majority of the British and German rental market. As a result, it had many shareholders (including several prominent venture-capital firms), a large board of directors, and plenty of conflicting internal opinions about its strategic moves. Amazon became the largest shareholder after the deal and later consolidated its grip on the startup when another investor, the European venture-capital firm Arts Alliance, sold the company a 10 percent stake. Greg Greeley, the former finance executive who was running Amazon’s European operation, joined the Lovefilm board. As it is wont to do, Amazon watched from the sidelines, learned, and patiently waited for an opening.
By early 2009, the home-video market was inexorably tilting toward streaming movies online and away from sending discs in the mail. Like Netflix, Lovefilm planned to transition to video on demand. It had arranged streaming deals with movie studios like Warner Brothers and put access to its catalog on devices like Sony’s PlayStation 3. But the company needed additional capital to execute such a shift in its business, so that year it hired the investment bank Jefferies and started entertaining acquisition and investment offers.
While private equity firms like Silver Lake Partners expressed interest, Google was the most prominent bidder for Lovefilm. The search giant’s executive team was developing a plan over the summer of 2009 to acquire both Lovefilm and Netflix and add a significant new focus that was unrelated to its core advertising business. Nikesh Arora and David Lawee, business-development executives at Google, had several meetings with people at both companies that year and produced a preliminary letter of Google’s intent to buy Lovefilm for two hundred million pounds (about three hundred million dollars), according to three people with knowledge of the offer. But these efforts ultimately fizzled; there was opposition from Google’s YouTube division and fear that the company might be able to acquire one streaming-video business but not the other.
That left Lovefilm still in need of additional capital. So over the summer of 2010, the company’s executives decided to pursue an initial public offering. Then Amazon decided it wanted to buy Lovefilm, and everything changed.
Amazon had watched the explosion in popularity of Internet-connected Blu-ray players and video-game consoles in its own electronics store and knew it had to get off the sidelines. Its incipient streaming service, Amazon Video on Demand, was the successor to an overly complicated video download store called Amazon Unbox, which required users to download entire movies to their PCs or TiVo set-top boxes before they could start watching. The streaming service (which did not require downloads) was showing early promise but the company still lagged behind Apple and Hulu in the online-video market. Buying Lovefilm would give it a beachhead in Europe. “They went from having a financial interest, where they thought they might make a financial return on their investment, to a strategic interest, ” says Dharmash Mistry, a former partner at the London venture-capital firm Balderton Capital and a Lovefilm board member. “They wanted to own the asset.”
Now the Lovefilm board members would witness the same ruthless tactics observed by the founders of Zappos and Quidsi. Amazon pointed out, quite sensibly, that Lovefilm needed to invest hundreds of millions to acquire content and hold off deep-pocketed rivals like the massive cable conglomerate BSkyB and, when it finally entered the European market, Netflix. Amazon also argued that Lovefilm needed to invest in its long-term prospects and should not spend time and money gussying itself up for the conservative public markets in Europe, which would want to see profits before an IPO. The best path forward was for Lovefilm to sell itself to Amazon. It was more Bezos-style expedient conviction—the arguments had the advantage of being completely rational while also serving Amazon’s own strategic interests.
In the midst of this debate, Amazon found a technical way to prevent a Lovefilm IPO. If the company was going to free up stock to sell to the public, it needed to amend its own bylaws, or articles of association—and as the largest shareholder, Amazon could block this change. It effectively had a veto over an IPO, and Amazon made it clear that it was not going to authorize or publicly endorse the move, according to multiple board members and people close to the company. This was an enormous problem. Potential investors were likely to balk if the company’s biggest shareholder was not visibly showing its support for the offering.
Lovefilm executives had several meetings with attorneys to try to find a way to extricate themselves from the situation. They also attempted to entice other potential acquirers, hoping to spark a bidding war, but without success. Everyone saw that Amazon was squatting over the asset.
Though Lovefilm was a prestigious European company with a strong brand and solid momentum, Amazon offered an opening bid of a hundred and fifty million pounds, the very bottom of Lovefilm’s price range. With no alternatives, Lovefilm started negotiating. In the protracted discussions that followed, Amazon characteristically argued every point, such as compensation packages for management and the timing of escrow payments. Lovefilm’s attorneys were astonished at the intractable positions taken by Amazon’s negotiators. The talks lasted more than seven months, and the acquisition was finally announced in January 2011. Amazon ended up paying close to two hundred million pounds, or about three hundred million dollars—roughly the same amount Google had offered despite the fact that Lovefilm had expanded its subscriber base and its digital catalog of movies in the intervening year and a half.
Amazon now had a strong foothold in the European video market just as it unveiled its most serious play for the living room. A month after it announced the purchase of Lovefilm, the company introduced a video-streaming service for Amazon Prime in the United States. Members of the two-day shipping service could watch for free a selection of movies and television shows, a catalog that would grow steadily over the next few years as Amazon inked deals with content providers such as CBS, NBC Universal, Viacom, and the pay-TV channel Epix.
Inside the company, Bezos rationalized the giveaway by saying that it sustained and even complemented the seventy-nine-dollar fee for Prime at a time when customers were buying fewer DVDs. But Prime Instant Video played another role. Amazon was now providing, as a supplementary perk, something Reed Hastings and his colleagues at Netflix priced at five to eight dollars a month. The service exerted direct pressure on a key rival and worked to prevent it from appropriating an important section of the everything store. Amazon too would offer films and TV shows in any form that customers could possibly want—all with the click of a button.
More Books By Brad Stone
We’ve created a list of books every aspiring/existing entrepreneur should read, and it’s nothing the book lists you will come across when you search for “Best Business Books” on Google. You can check out the list and our explanation of why we created it here.